Thank You

Error.

Supposedly, the problem is arithmetic. Republicans and Democrats can't reach agreement on averting the fiscal cliff because each side says it has the only true understanding of the numbers. President Obama and the Democrats say the country can't come back to sound fiscal policies without raising the top rate to 39.6%. But House Speaker John Boehner and the Republicans say the country can't come back to sound fiscal policies with a 39.6% rate on high incomes (not to mention the 3.8% Obamacare surtax on dividends and capital gains and the 0.9% Obamacare surtax on wages).

The president told the Business Roundtable last week, "It is not possible for us to raise the amount of revenue that's required for a balanced package if all you're relying on is closing deductions and loopholes." Of course he repeated, "It's simple arithmetic."

Take More

The Democrats are right that the country does need more revenue. The U.S. takes only 15.8% of gross domestic product to feed the government -- the lowest percentage since 1950 -- while federal spending is 24.3%, second only to 2009 in the period since 1945.

But Obama is wrong on the arithmetic. It is possible to raise a lot of revenue without raising rates. Eliminating all special income exclusions, special reduced rates, special deductions, and special credits from the personal and corporate income-tax codes would raise the tax take by $1.1 trillion or so, roughly equal to the current annual take from the personal income tax, and roughly equal to the whole deficit for fiscal 2012.

Like the president, everyone seems to believe that eliminating special interest -- and general interest -- tax bonanzas is politically impossible, but the only way forward is to cut them all out, without fear or favor.

Democrats ought to recognize that the bulk of these tax breaks benefit the top 10% of income earners, but they are sticking to the symbolic issue of raising rates.

When the president says, "We're going to have to see the rates on the top 2% go up, and we're not going to be able to get a deal without it," he's not talking arithmetic; he's talking politics.

The Republicans say the country needs a drastic change in spending priorities, not higher taxes. High tax rates on personal income, and on business profits reported as personal income, are not likely to be good for the country in the long run, though simple arithmetic doesn't prove the point.

A minor increase of 4.6 percentage points on the most luxurious incomes might not cause much harm in the short run, even if we remember to consider the Obamacare taxes.

In the long run, however, history will not absolve us. Either there will be stagnation -- as in the 1930s -- or the high rates will be offset by new special-interest legislation increasing the size and number of tax breaks -- as in the 1940s and 1950s, when the nominal top tax rate was more than 90%.

Of course, it will be worse this time. The U.S. was a different country in those bygone decades. Demographics, globalization, and information technology all operated in our favor, enough to overshadow tax policy. Now the U.S. is aging, exporting jobs and importing technology; oppressive tax policy will magnify those problems.

Hungry Beast

One other thing has become clear: The classic Republican idea of "starving the beast," meaning the use of tax cuts to deprive the government of some of its vital essence, leads to impossible arithmetic.

Starving the government by cutting its revenues depended on the belief that there was some size of deficit that would cause the people and their elected representatives to recoil in horror and get busy to repair the fiscal disaster.

Credit Milton Friedman, who said in 2003, "How can we ever cut government down to size? I believe there is one and only one way: the way parents control spendthrift children, cutting their allowance. For governments, this means cutting taxes. Resulting deficits will be an effective -- I would go so far as to say, the only effective -- restraint on the spending propensities of the executive branch and the legislature. The public reaction will make that restraint effective."

But parents know that cutting a kid's allowance won't work if he has their credit card.

The U.S. government has the luxury of borrowing in its own currency, which is the best kind of credit card because it doesn't have to do anything to get money. All it needs is a compliant Federal Reserve.

Tax cuts also reduce the perceived price of government: When a billion dollars of new spending is paid with a billion dollars of taxation, all taxpayers feel the full pinch. When a billion dollars of new spending is paid for with a billion dollars of new borrowing, the taxpayers feel only the pinch of the interest charge. At current rates, the pinch is a negligible $20 million or so.

The idea of starving the beast ignored the impossibility of satisfying an infinity of human desires. Having our cake and eating it too is our natural goal in life, even if we aren't running for office.

Easy Money

Considering how easy it is to borrow in a world that considers the U.S. Treasury a safe harbor; the wonder is not that the U.S. owes so much, but that it owes so little -- so far. We are ignoring the beast within us because nothing bad has happened -- so far. If the beast is hungry, we feed him without thinking about how to pay for it, because borrowing is so simple. We go into debt to feed him without counting the cost, as long as our creditors will lend us more.

It's an ominous sign, by the way, that China has curtailed its role as the chief enabler of the U.S. borrowing addiction -- and even more ominous that few Americans have even noticed.

Between September 2011 and September 2012, China reduced its holdings of U.S. Treasury debt 9%, from $1,270 billion to $1,155 billion. The Fed helps investors and governments in Japan, other Asian nations, and Europe pick up the slack.

If the Chinese are starving the beast, we had better hope the rest of the world does not join in.